The European Central Bank (ECB) has cut interest rates by a quarter point to 4.25% on the day it kicks off the countdown to the euro's introduction as a cash currency.

The rate cut had been widely predicted by observers, who expected the bank to give a lift to stagnating economies in Germany - Europe's traditional powerhouse - Italy and elsewhere.

Nevertheless it gave a boost to the euro on currency markets. Europe's single currency strengthened to 91.29 US cents shortly after comments made by ECB president Wim Duisenberg about the rate cut.

The new level of interest rates is compatible with the maintenance of price stability in the medium term... We obviously tended to be too optimistic about the duration and the depth of the slowdown in the US

Wim DuisenbergECB president

Inflation in the eurozone is still well above the ECB's 2% target. But, for once, the bank discounted inflation worries and moved to encourage growth instead.

Recent months have seen price rises slowing in Germany, France and Spain, while July eurozone inflation fell to 2.8% year on year from a 3% annual rate in June.

Inflation outlook improves

"There are clear signs of a lowering of inflation pressures
from the demand side," Mr Duisenberg told a news conference following the decision.

"The new level of interest rates is compatible with the maintenance of price stability in the medium term," he said, casting doubt on the chances of more cuts in the near future.

"Real GDP [gross domestic product] growth in 2001 will most likely be slower than expected only a few months ago."

He denied the suggestion that the ECB had underestimated the impact of the US slowdown.

Finally, we see what we had expected... It shows that the ECB is more responsive, that it is really confident that inflation will go down

Adolf RosenstockNomura

But he did admit that its length and severity had come as a surprise.

"We obviously - may I say together with the US authorities - tended to be too optimistic about the duration and the depth of the slowdown in the US."

Surprise, surprise

The ECB's habit has been to buck expectations.

Its second rate cut this year - in a period during which the US Federal Reserve has sliced rates seven times to 3.5%, and the Bank of England in the UK has moved four times to reduce borrowing costs by one percentage point - surprised investors.

The launch of euro banknotes and coins, due to replace national tender on 1 January 2002, could have given the Bank an excuse to delay a cut.

But Thursday's move is one of the few occasions that reality has lived up to the forecasts.

"Finally, we see what we had expected," said Adolf Rosenstock, from Nomura in Frankfurt.

"It shows that the ECB is now more responsive... that it is really confident that inflation will go down and hereby should actually help to stabilise the expectation of low inflation."

More to come?

But opinion is divided about whether more cuts are in the pipeline.

Welteke: ECB has "no mandate for growth"

"We think they will now leave interest rates unchanged at this level because there will be some encouraging signs from the US and Germany regarding economic developments," said Heinrich Engelke from Bankgesellschaft Berlin.

"I think we have seen the last cut in the US and I think the ECB has also finished."

But Stephen Pearson, of the Halifax in London, pointed out that the risks "remain clearly to the downside".

"We're looking for rates to get down to 4% over the next four or five months," he said, "but it's questionable whether they'll get another cut in before the end of the year."

Caution rules

Wednesday's intervention by Bundesbank president and ECB board member Horst Welteke was taken in some quarters as evidence that the ECB would refuse to budge.

"The ECB council does not have the mandate to steer growth but to keep the value of money stable," he said.

"The ability to fine-tune growth is clearly over-estimated, the lags with which monetary and fiscal impulses work, underestimated."

And a recent surge in the money supply, despite ECB insistence that the figures were distorted, had cast yet more doubt on the likelihood of a cut.